"The Course of Empire": A Retrospective On The US Housing Crisis

A decision by the FHFA requiring the GSEs to finally release detailed information on loans they acquired and guaranteed uncovers an ugly truth about the GSEs that many should be aware of (as we noted the exuberance here). The release was only required on 35 million fully-amortizing, full documentation, 30-year fixed rate mortgages, which means as JPMorgan's Michael Cembalest notes the underwriting histories on another 20-30 million loans (e.g., the riskier ones) remain a mystery (and likely will forever). As Cembalest concludes, some people made up their minds on all the factors causing the housing crisis in 2009, and others in 2011. As long as new information keeps coming out, it seems premature to close the book on it, he adds, first, the private sector descent into underwriting hell took place well after the multi-trillion dollar GSE balance sheets had gone there first; and second, there are many reasons to wonder how bad the former would have been had the latter not preceded it.

Via JPMorgan's Michael Cembalest,

"The Course of Empire": A Retrospective On The US Housing Crisis

Thomas Cole’s 19th century paintings entitled Course of Empire, chronicling the rise and fall of civilizations, have been reinterpreted below as a commentary on the US housing crisis. Why now? This retrospective is made possible in part by a decision by the Federal Housing Finance Authority requiring Freddie Mac and Fannie Mae to finally release detailed information on loans they acquired and guaranteed1. The release was only required on 35 million fully-amortizing, fulldocumentation, 30-year fixed rate mortgages, meaning that the underwriting histories on another 20-30 million loans (e.g., the riskier ones) remain a mystery. Some people made up their minds on all the factors causing the housing crisis in 2009, and others in 2011. As long as new information keeps coming out, it seems premature to close the book on it; it took 30 years for Friedman to diagnose the Great Depression. This latest disclosure, though partial and purposefully incomplete, adds to the evolving understanding of what took place, why, and in what sequence. Everyone is entitled to their opinion; the charts and the data below explain mine.

“The Pastoral State”

Informed by the experience of the 1980’s housing crisis, by 1990, government sponsored enterprises Fannie Mae and Freddie Mac adhered to prudent underwriting on single family mortgages. The GSEs had a small allowance for loans outside traditional investment-grade standards: loans with debt-to-income ratios above 38%, loan-to-values above 90% on purchase loans, or loan to values on cash-out refinancing loans above 75%2. However, these exceptions were typically justified by compensating factors such as higher cash reserves or higher levels of equity. Even the Federal Housing Administration, which focuses on lower income households and first time homebuyers, acted with more restraint than in later years when measured by their LTVs over 97%.

The GSEs had a one third share of outstanding mortgages compared to GSE plus private sector lending. Private sector subprime had existed for decades, but was limited in size at ~10% of annual residential mortgage origination. Home ownership rates and home prices relative to income and replacement cost were stable at post-war averages.

“Consummation of Empire”

The era of sound GSE lending did not last. The 1992 “Federal Housing Enterprises Financial Safety and Soundness Act” enabled the Department of Housing and Urban Development to set formalized minimum affordable lending standards for the GSEs. Only George Orwell could have named a bill that was so fundamentally contradicted by its purpose and consequence. HUD first set Low & Moderate Income standards at 30% of annual GSE acquisitions, and raised them to 50% in the week before the November 2000 election. In the wake of the bill, in 1994, Fannie Mae issued a press release citing its commitment to transforming the housing finance system, vowing to provide $1 trillion in targeted lending, and citing a goal of eliminating the “no” in the mortgage application process. Prudent 1990 GSE underwriting standards, designed to benefit future borrowers and not just current ones, were discarded. Home ownership rates jumped, and home prices relative to replacement cost, rent and household income began to rise above historically stable levels.

By 2002, the revolution is complete: the GSEs increased their market share from one third to 60% as the size of the mortgage market rose by 2.5x vs. 1990; Freddie Mac’s non-traditional loans were ~45% of their annual acquisitions and guarantees; Fannie Mae claimed that the FHA was its only competitor, asserting that it had become overwhelmingly an affordable housing company; and more than 40% of Fannie Mae’s Alt A (low documentation) loans qualified for the HUD-determined affordable housing goals. These developments were celebrated by HUD as a “revolution” in affordable lending. In 2002, Nobel Laureate Joseph Stiglitz and future OMB Director Peter Orszag cited the probability of a shock to GSE balance sheets as “substantially less than one in 500,000”, and estimated the expected cost to the government of guaranteeing $1 trillion of mortgages at $2 million. Yes, you read that correctly.

Note that the GSE revolution takes place before the explosion in private sector subprime and Alt A loans. The private sector, seeing its market share shrink, organizes several not-so-successful efforts to constrain GSE expansion. Private sector subprime and Alt A market shares remain constant, but its underwriting becomes riskier as the GSEs encroach on their territory with a multi-trillion dollar balance sheet.

“Prelude to Destruction”

GSE non-traditional loans eventually converge to 40%-50% of their annual underwriting, culminating with a warning from Fannie Mae to shareholders about losses from affordable lending. There are some remarkable quotes from HUD in 2000 on how it expected this GSE revolution to result in a private sector revolution as well; it eventually did. The private sector finds a way to compete: the deepening of private mortgage backed securities markets. Propelled by demand when the Fed cut policy rates to 1% in 2002, PMBS markets did not price much of a differential between subprime and traditional risk. As a result, the funding advantage enjoyed by GSEs was conveyed to private sector originators. Privately securitized mortgages skyrocket, home prices surge further, and the mortgage market doubles in size vs. 2002. The private sector regains market share, mostly through subprime and Alt A loans which rose to 40% of annual origination. To be clear, private sector defaults and losses per dollar on subprime were much worse than on GSE loans, particularly when related to malignant derivative offshoots. To complete the circle, the GSEs support private sector origination by purchasing $275 billion of mostly subprime mortgage-backed securities by 2005. With these trends in place, it’s only a matter of time before it all comes undone.

I did not reproduce Cole’s last painting in the series (“Desolation”) since we know what came next. The paintings above convince me of 2 things. First, the private sector descent into underwriting hell took place well after the multi-trillion dollar GSE balance sheets had gone there first. Second, there are many reasons to wonder how bad the former would have been had the latter not preceded it. I have doubts that public consciousness is aware of this timeline and the impact of public policy on it, and stronger doubts that data on the millions of undisclosed, riskier Fannie Mae and Freddie Mac loans will ever be released. Let’s just leave it at that.

1. The decline in America's economy is matched by the increase in TBTF banking expansion?

2. The decline in America's democracy is matched by the increase in Statism?

3. The decline in America's consumption is matched by the increase in hand-outs, thus debt?

4. The decline in America's foreign influence is matched by the increase in internal [state] influence?

5. The decline in independence of the American citizen is matched by the increase in reliance upon the state, and in turn, the reliance upon the banks to which the Government is controlled by?

When all these checks and balances are taken into account, you will note that for every decline there is a corresponding increase...somewhere! If you bothered to stand back and look for it, you would clearly see it.

America is not necessarily going through a decline, it can easily be argued that America is in fact going through a power, control and wealth metamorphosis...and it is not going to look like a fucking Butterfly!

I have not bothered to write and update a lengthy blog in order to sell advertising space; my goal is to get people to step back and look at the broader picture...something many sites seem to ignore due to all the noise.

"yyou are aggrandizing a superfluous "idea", it's meaningless, unhelpful, misdirective and.................................boring" So why read it, why respond, why get all worked-up about it. I don't have a gun to your head forcing you to read my post, or see my way of thinking. It is in fact YOUR choice to read and YOUR choice to respond...it's also YOUR choice as to whether you get aggravated by it or not (the Dog barking next door). If your neighbour paints his mail box blue do you get all fired-up about it because blue isn't YOUR vision of what a mail box should look like?

Also, I used the phrase, "it can easily be argued that", so as not to force my opinion upon anyone. You however, have taken my comments as though I were Moses coming down the mountain with the 10 Commandments in arm.

"WHY? do you do the typical american thing and distort language to a game of semantics" Good thing I'm not American, hey?!

Truth is, I'm glad you're pissed off, I'm glad I've irritated you, because it simply means you've read my post/s and are attempting to come to terms with what I'm saying. It's irrelevant whether your belief system is in conflict with what I've written because belief systems constantly evolve anyway.

The greatest asset anyone can have at this stage of the game isn't Gold or Silver, it isn't Land or Bonds, and it certainly isn't a Bomb Shelter in the Woods miles from nowhere, it's flexibility in thinking!

A question for you: do you always put time and energy into things which you find to be..."meaningless, unhelpful, misdirective and boring"?

Something tells me that what you feel and what you say a polar opposites...I'm right, aren't I?!

I put it to you that I've stirred up something you're trying to suppress; I've pinched a nerve somewhere. I reckon your conscious mind is acting aggressively dismissive but underneath your subconscious mind is yelling at you...but what is it yelling?

IMO people with a Normalcy Bias rationalise, through cognitive processes, one or many particular viewpoints which are more comfortable even when that viewpoint is in major conflict with intuition, instinct and in many cases even data/facts. When faced with a viewpoint which conflicts with their cognitive rationale, but is in conjunction with their gut instinct, they fight it and become even agressive against it. I believe this is an internal fight for control of ones belief system; a left versus right brained battle for internal directive, thus pathway through life.

THAT, is what I see in your post. THAT, is precisely why I write and continue to write my blog.

So when I re-read your posts, I don't see your words and thier meaning at all; all I see is the fight you're having within yourself.

The Mortgage Bankers Association reported today that applications for home loans fell last week for the fourth time in five weeks. The industry group's market composite index headed lower by 2.3% compared to the previous seven-day period. This marks the fifth time in 10 weeks the index has decreased. At the present level, it's off its May high by 54%.

Government central planners are like grade school kids at the controls of an airplane. They pull levers, push buttons and claim to know what they are doing in incredibly complex systems they do not fully comprehend. When the plane crashes, like kids they will blame someone else.

Note that the GSE revolution takes place before the explosion in private sector subprime and Alt A loans. ...The private sector finds a way to compete: the deepening of private mortgage backed securities markets.

Well, that's an interesting take, but I must disagree. So the banksters eventually followed suit? Perhaps. But even early on they were complicit in *buying* the crap that the GSE's were selling.

So if this is meant to blame the GSEs and the gobmint instead of the banksters, kiss off, plenty of blame to go around.